What is Working Capital

Working capital means what it says, which is why balance sheet forecasts including working capital are vital for any kind of business plan.

A Business Runs Out of Cash

Stories abound about businesses that has fail because the bank refused to advance new cash to pay wages or the rent. The bank is then usually held to be responsible for the consequent failure.

In the majority of cases this is not the case. The real reason for a proble like this is cash flow insolvency: i.e. is When a business can no longer meet its liabilities as and when they fall due.

The cause cause will be insufficient or negative working capital in the balance sheet measured by net current assets; representing the liquidity of the business.

How to Calculate Working Capital

Cash plus items such as accounts reecievabe and stock which are cash convertible within 12 months (current assets) less all liabilities payable with 12 months (current liabilities) describe net current assets. 

That in turn describes working capital which, when forecasting using Figurewizard must never be shown in deficit.

Planning Working Capital and Cash

While a forecast returning positive working capital is vital, it doesn't follow that things will run smoothly over the coming year.

For that reason it is always important to check the forecast for the monthly cash flow, bank and finance budget. If any months are in deficit it will important to revise your business plan to eradicate any monthly deficits. The What-If Calculator and Planner is ideal for this.

Working Capital and Current Assets

Apart from cash and investments in lieu of cash that can be called in on demand current assets are those which are cash convertibles within twelve months.

They will include accounts receivable and stock / inventory plus prepayments such as insurance premiums for however many months the premium will run beyond the end of the financial year.  Note that fixed assets of whatever stripe are never considered to be "current".

Working Capital and Current Liabilities

Current liabilities on the other hand are all debts falling due for payment within twelve months.

Those debts are not restricted to core trading activities. All debt means what it says e.g. VAT and other taxes, bank overdrafts (which are always assumed to be repayable on demand) or other loans such as those concerned with the acquisition of fixed assets which are payable within twelve months.

Working Capital Deficits

If current liabilities are greater than current assets, a business is insolvent even if it hasn't yet run out of cash.

That will be just a matter of time and a bank that is not forthcoming during the inevitable emergency that arises can hardly be blamed for that. If you want to be certain that your business will avoid this, then you absolutely must first plan and forecast the balance sheet, in order to forecast your working capital.

Follow the link below to view a working example of a Figurewizard balance sheet forecast to view the calculation of a forecast for working capital.

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